Friday’s Reader Question: How do I Buy an Exchange-Traded Fund?

October 27, 2006

I’m going to try to start doing something new on Fridays. Each Friday I want to post a reader question, offer my response, and then open it up to you guys to weigh in with your thoughts. For those who are interested in asking a question, you can email your question to me using the email address located in the upper lefthand corner. Please be sure and put “Friday Question” in the subject line. I can’t promise that I will post your question but if I do, I promise not to use your name in the post.

That said, here’s today’s Friday Question:

Hello,

My name is E. and I have been reading your blog for a few months. I’m starting to get a grip on my personal finaces and I was wondering if I could ask you a few questions. I am reading the reviews of the Boglehead’s guide to investing. It sounds like a good book. I think that I will borrow it from the library. I might not know enough to really understand it. I think the book might be way over my head and I really want to learn about finances.

My main question is (please do not laugh). If I wanted to buy an ETF where would I go? Is there an etf store? How much money do I bring to buy an etf? I don’t want to appear like an idiot.

My response:

E.,

You don’t look like an idiot. I think it is great that you took the initiative to ask the question.

First off, you have to decide if an ETF is even right for you. Because ETFs trade like a stock, there are commissions each time you buy or sell one. So, if you are investing a small amount of money on a regular basis, then you would probably be better off investing in a no-load index fund.

Now to answer your question:

As I said before, an ETF trades like a stock. In order to buy an ETF, you need two things:

2. The name and ticker symbol of the ETF you want to purchase. You can find this information on the YahooFinance ETF website, which contains a WEALTH of information.

As far as how much money you need in order to purchase and ETF, it depends. You will need enough to purchase the ETF and pay for the commission. If you have an account with Sharebuilder, you can buy fractional shares. Here’s an example of what a fractional share is:

Say you have $100 to invest and you want to buy an ETF that is trading at $78 per share. Sharebuilder charges $4 to do the trade, so you have $96 to put toward your purchase, which would buy you 1.2307 shares ($96 &#247 $78 = 1.2307) of the ETF. In other words, you only have enough to buy ONE full share and about 1/4 of another share.

Now it is time for readers of AFM to weigh in. What are your thoughts?

11 responses to Friday’s Reader Question: How do I Buy an Exchange-Traded Fund?

I like buying ETFs. It gives me a wider group of stocks that just buying individual companies. It’s easy to get exposure (a good and a bad thing) to areas where I couldn’t afford to diversify with individual companies.
I own ISHARES MSCI BRAZIL INDEX FD (EWZ), SPDR TR (SPY) and some SELECT SECTOR SPDR FD ENERGY SELECT (XLE) as well as a portfolio of individual companies. Note that this is not a suggestion for anyone to buy them (or nail me to the wall for my choices). It’s just to show that they’re ubiquitous and anyone with a brokerage account can get in on them. I buy a few shares whenever I have a few dollars in my brokerage account. I’m fortunate in that my trades cost only $4 each. To me, that’s a small “cost” that I can spread across the number of shares I buy (and I’m lucky that I have such low cost trades). So I don’t really count the brokerage fee too much. Hopefully, the $4 will be outweighed by the fact that I’m constantly buying and staying in the market for the long term. In 10 years, hopefully the stocks’ growth will more than make up for the broker fee.
I know that there are a lot of people that are chomping at the bit to tell me how much $4 compounded over that 10 years is… I’ve probably cost myself a new car by now…
Oh well…

Although I can be of no help regarding ETFs (another beginner investor here!) a thought has just occurred to me concerning the ‘cost’ of trading/purchasing a share/whatever.

If you are buying/trading a security/fund/whatever, and are doing so for retirement/savings reason (i.e., you actively want to save) then maybe the commission/fees can be disregarded in a way. You are making the effort to stash some of your income away for future growth and eventual use, so the $4 charge could be offset (in your mind at least:) ) by the fact that you are strengthening your future financial position rather than keeping that money in the bank which you will – almost without question – manage to spend on something with no where near the financial returns the stock/fund will ultimately bring.

Thus, ironically, you pay a premium for (hopefully) securing your financial future, but this cost can be balanced by the actual act of saving/investing rather than spending the money.

Very waffle-y, I know, and perhaps someone could(already has?) word this a little better, but I hope this helps the cost-benefit balance towards people investing/putting money away in inflation-beating securities for the future.

I know charges can eat up returns, but wouldn’t you rather spend money investing in your financial future than on another overpriced double mocha frappachino!

ETFs can be a great way to go, but they’re multiplying like crazy. Not all are low-cost, and not all are good performers. There were as of July over 212 of them and growing at a rate of over 33% a year. Choosing an ETF still takes research and legwork.

I’d have to agree with Suresh here. From the sound of the reader’s question, I’d recommend she learn about the basics of investing first before just jumping in with an ETF. I own several ETFs and have written about some of my experiences with them, but understanding why you’re investing, your approach, and your goals are fundamental and important to establish first before diving in the stock market with your cash, be it for stocks, ETFs, bonds, or what have you.

I’ve gotten that question about where to buy ETFs a bunch of times before. I’m currently #3 on google for “Powershares” because of an interview I did. People seem to think that I am a Powershares dealer… it’s hard to explain that I am… sort of… but not really. Anyway, buy an ETF from http://www.zecco.com. They actually offer free trades and have phone-line customer service. It’s a pretty good deal.